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Target practice

The damage done over the past few weeks in the equity markets heralds a difficult phase for the investment industry.

The UK equity market, as measured by the FTSE 100, has never surpassed its high in December 1999. Investors’ memories of 2001-03 are still alive and now we could see those lows again. However, in market falls, the next opportunities are found and now a new breed of absolute funds are offering to preserve and even make money in difficult market conditions.

The term “hedge fund” has been somewhat hijacked in recent years and carries an aura of danger and risk. It is wrong to tar all hedge funds with that brush. Those that have gone horribly wrong are not proper hedge funds at all but little more than gambling funds. One might as well put one’s savings on the 2.30 at Sandown.

A true hedge fund will seek to preserve capital above all and endeavours to make positive gains through the market cycle.

Typically, hedge funds aim to produce returns in the region of 8 to10 per cent a year. During a bull market, when the FTSE All Share might rise by 20 per cent in a year, this will look pretty pedestrian. However, the best hedge funds can deliver these returns consistently, so they might also grow by 8 to 10 per cent when the market is down by 20 per cent.

They were once the preserve of the super-rich but now very similar vehicles are available to investors through Ucits III. This regulatory framework means managers of retail funds can begin using some of the sophisticated investment techniques which were previously reserved for hedge funds.

One example is the ability to short. The principle behind shorting is that a fund manager agrees to sell some shares that they do not own.

The buyer agrees that they will not take delivery of the shares for, let us say, six months. After six months, the fund manager buys the shares in the market and passes them on to the buyer.

For example, let us say a fund manager shorts 100,000 shares with a price of 150p and therefore receives a payment of £150,000 from the buyer. Six months later, the manager buys the shares in the market but now the price is only 120p. He buys 100,000 shares for £120,000 and gives them to the buyer as agreed, leaving the fund manager £30,000 in profit for the transaction. Of course, if the price had risen to 180p, the manager would have lost £30,000 instead.

The Cazenove UK absolute target fund is a new launch which will be managed by Tim Russell. He has been running a hedge fund since November 2003 with impressive results. The differences are subtle, for example, using contracts for difference and the fact that it has daily dealing rather than monthly. However, it should not alter the basis of the way the fund is managed.

His hedge fund has returned around 9 per cent annualised net growth since launch and has done this with considerably lower volatility than the FTSE All Share index and also achieved it with very few down months.

I think this fund should have wide appeal. For a novice investor, perhaps making their first-ever investment, it should offer some confidence that they will not be hit too hard by a market crash. For experienced investors, it could provide a solid core around which to build a portfolio of more aggressive funds. Finally, for those who have built up a big nest egg in their Isa or pension over the years, this fund should provide a way to give that capital some protection while still targeting returns greater than cash.

There is an annual management fee of 1.25 per cent on this fund but be aware that it also has a 20 per cent performance fee on any positive returns. This certainly makes it expensive and I would prefer it if the fund had to beat cash before the performance fee was charged.

That said, there are not many managers who can manage this type of fund, nor many groups who are able to offer one. Sometimes you have to pay a premium fee if you want a premium product.

The only other fund available like this is the BlackRock UK absolute alpha fund which has performed extremely well through volatile markets. I think both funds dovetail well together, so there is no reason not to split your investment between the two of them for added diversification.

This is genuinely a fund for the long term and is the type of investment that wealthy individuals have been using for many years. I am glad it is now reaching us ordinary people.

Mark Dampier is head of research at Hargreaves Lansdown

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